While I have always focused on trying to make presentations for judges as understandable as possible, I have been thinking about this topic a good bit during the past year. By the time the year is over, I will have spoken on this topic of simplifying complex financial information for judges and juries a number of times around the country. Sometimes, it is a single graphic that helps convey the reasonableness of a complex series of opinions. This post is about one such graphic.
The case was the largest corporate dissolution matter in New York history. The company was AriZona Iced Tea and two parties were fighting over its value, or rather, its (statutory) fair value under New York law. A fairly detailed write-up of the case can be found here, which is worth the read.
For all of its complexities and fighting over extraneous matters between two 50% shareholders, the core issue was the fair value of AriZona on the specified valuation date according to New York dissolution law.
While there were lots of experts on a variety of issues, the core valuation opinions were presented by a college professor (for the Company) and me (for the selling shareholder). While the valuations were complex and had many nuances, the core of each appraisal was a financial forecast of AriZona’s performance. The key differentiating factor between the appraisals was their respective forecasts of EBITDA for the decade beyond the valuation date.
Financial forecasts for purposes of valuation can be examined in relationship to:
- The prior history of a company for each important line item
- The historical margin performance of a company
- Margins for comparable public or private companies, depending on availability
- The management’s ability to deliver the forecast (perhaps informed by history)
- Trends in the company’s industry that could impact its outlook
- And more
Appraisers make these comparisons every time a financial forecast is performed in any appraisal. In litigation, the forecasts are often compared side-by-side.
The idea is that appraisals must make sense in light of the above analytical factors and in view of what I call the “critical three” of valuation: common sense, informed judgment, and reasonableness. These factors, by the way, come from Revenue Ruling 59-60.
One Figure Tells the Story in AriZona
Cutting through all the complexity, I’m convinced that a single diagram used in my direct testimony told the story of the better projection in a compelling way for the court. The figure compares historical EBITDA margins with the margins implied by my forecast and with those implied by the opposing expert’s forecast.
You pick the more reasonable forecast based solely on the information provided so far.
The Main Lesson
We certainly did not rely solely on the single chart above in conveying my valuation opinion to the court, but we knew that it told the story about the two forecasts in a compelling and simple way that leaves only one possible conclusion regarding the more reasonable forecast.
We wanted the chart to be simple and understandable. There was no evidence of looming poor performance for AriZona at the valuation date. We started with charts with multiple elements and ended with the chart above.
The lesson is that simple can work. As appraisers, we often get so involved in our complex methods and theories that we forget to try to relate them to the users of our reports who are likely not trained in our field.
For me, the main lesson from AriZona is that a single, fairly simple chart won the day by illustrating first, the reasonableness of my forecast in light of history, and second, the unreasonableness of the opposing expert’s forecast.
So that’s the main lesson learned. Keep it simple when we can.
New Books on the Way
- An Attorney’s Handbook for Buy-Sell Agreements (in production). This book provides guidance based on 30-plus years of dealing with buy-sell agreements. Importantly, it provides for the first time ever, anywhere, draft template language for the valuation portions of buy-sell agreements that will work for clients or companies. You will not want to miss this book!
- Business Valuation: An Integrated Theory Third Edition (with Travis Harms). The draft is due to the publisher (Wiley) shortly and will be available subject to their publication schedule. This book updates the Integrated Theory of Business Valuation and will include the Integrated Theory on an equity basis and on an enterprise (total capital) basis, as well. This book will be must reading for all business appraisers and anyone interested in business valuation.
E-mail me if you would like to be notified when these books become available.
In the meantime, be well!